Remarks Of
Richard Y. Roberts
Commissioner*
U.S. Securities and Exchange Commission
Washington, D.C.
"Current Issues Involving Bank Securities Activities"
The Bankers Roundtable Lawyers Council Meeting
Washington, D.C.
May 18, 1995
____________________
*/ The views expressed herein are those of Commissioner Roberts
and do not necessarily represent those of the Commission,
other Commissioners or the staff.
I. Introduction
I appreciate the opportunity to participate in this Bankers
Roundtable's Lawyers Council Meeting. When I appeared before the
Bankers Roundtable last fall, I shared with the audience my
concerns pertinent to bank mutual fund and other securities
activities. Today, I will revise and update those remarks, and
then review the current initiatives to reform the Glass-Steagall
Act.
II. Bank Mutual Fund Activities
I will begin with bank mutual fund activities. Bank entry
into this area, both in terms of managing mutual fund assets and
selling mutual fund shares, has increased substantially over the
last decade. The increased competition and convenience offered
by bank involvement in the mutual fund area should benefit
consumers, and I personally welcome such involvement.
But for bank share of the investment company market to
continue to grow, investor confidence must be maintained. In
this regard, bank mutual fund participants should not only be
mindful of their own individual mutual fund operations, but
should be willing to point out questionable practices that may be
occurring in connection with other bank mutual fund activities,
such as identifying those stretching too far for short-term yield
or engaging in inappropriate sales practices.
The federal banking regulators are now focusing more
attention on bank mutual fund sales practices. In 1994, the
federal banking regulators issued a joint "Interagency Statement"
concerning bank sales of mutual funds and other securities which
replaced guidelines issued by each agency. While I support many
of the objectives of this Interagency Statement, I am troubled
that the guidelines included therein may not be legally
enforceable by either the regulatory agencies or by bank
customers. Moreover, I am concerned that application of the
guidelines by the banking agencies may result in overlapping and
potentially conflicting layers of regulatory oversight for those
registered broker-dealers that sell securities and provide
services to bank customers.
At the very least, greater coordination of regulatory
activities between the Commission and the federal banking
regulators is needed to prevent such overlaps and conflicts from
occurring. I note in this regard that the staff of the
Commission and the Office of the Comptroller of the Currency have
discussed conducting joint inspections of banks that advise
mutual funds, and the funds themselves. An announcement on this
matter is expected shortly and perhaps efforts such as these will
ease my concerns regarding regulatory conflict and overlap that
are potentially raised by the Interagency Statement. Of course,
the larger issue of regulatory duplication at the federal level
over bank securities and mutual fund activities has become an
increasing problem which has yet to be satisfactorily resolved,
and this problem will remain a challenge in the future for
federal financial services regulators to overcome.
Along similar lines, I understand that the NASD also has
stepped into the fray, proposing rules that would oversee the
activities of broker-dealers selling securities on bank premises.
The NASD's proposal appears to be targeted at easing customer
confusion with respect to such sales. The NASD proposal would,
among other things, require broker-dealers to: provide services
physically separate from where retail deposits are taken;
establish and enforce procedures for supervising services
provided on bank premises; comply with restrictions on the
activities and compensation of unregistered employees; and make
specific disclosures to customers. It is my further
understanding that the NASD proposal generally follows certain
principles set forth in a 1993 Commission staff no-action letter
(to Chubb Securities Corp.) regarding networking arrangements
between depository institutions and registered broker-dealers.
The NASD has received 300 or so comments so far on its
proposal, and I have been informed that the comments from the
banking industry have been uniformly negative. Since the NASD
currently is reviewing its position and has not submitted a final
proposal to the Commission, I hesitate to comment too much
thereon. Nevertheless, I would like to see agreement on proposed
rules which provide reasonable investor protections, and the NASD
appears to me to be the appropriate regulator to impose such
rules.
I will close on the subject of bank mutual fund activities
by renewing a frequent call to eliminate the definitional
exemption in the Advisers Act for banks acting as advisers to
investment companies. Bank investment advisers are not required
to register with the Commission and are not subject to Commission
oversight under the Advisers Act, although bank advisory
relationships with mutual funds are subject to the Investment
Company Act. Consequently, Commission examiners do not gain
access to all the books and records normally available when
advisers register. Banks also are not subject to the substantive
requirements applicable to registered investment advisers, such
as the regulation of performance fees, procedures to prevent
misuse of non-public information, and the Advisers Act anti-
fraud provisions.
The current Advisers Act exemption, much like the Exchange
Act exemption from the definition of broker and dealer for banks,
appears to have its origin in the fact that the enacting
legislators believed that these exemptions were appropriate
because the Glass-Steagall Act prohibited banks from entering the
mutual fund business. Since this rationale no longer exists,
neither, in my view, should the exemptions.
III. Bank Securities Activities
The various investor protection issues arising from expanded
bank securities activities, including mutual fund operations,
have continued to spark debate over the appropriate regulation of
such activities. For example, Congress, the Commission, and the
federal banking regulators have expressed concern as to the scope
of federal deposit insurance protection. While there has
occurred vast improvements in investor understanding recently in
this area, concerns linger that some investors continue to
misunderstand the uninsured status of bank sold securities and
mutual funds. Some customers also apparently continue to be
confused about the protections afforded by the Federal Deposit
Insurance Corporation and the Securities Investor Protection
Corporation. Further, I personally am troubled by the status of
nonbank purchasers of bank loan participations under the federal
securities laws. In my view, purchasers of similar financial
instruments, such as loan notes and commercial paper, should not
receive vastly dissimilar information on their investments.
Although most of the legislative and regulatory focus this
year has been on broader Glass-Steagall reforms, several ongoing
or recent initiatives focus more directly on concerns with
respect to bank securities activities. For example, two separate
GAO studies are examining bank mutual fund practices and bank
securities regulation. In addition, two bills have been
introduced in the 104th Congress which directly address bank
mutual fund and securities activities.
Congressmen Gonzalez and Schumer have introduced a bill that
would codify and in some instances supersede the banking
regulators' guidelines for bank sales of "nondeposit investment
products," including mutual funds. Senator Pryor has introduced
legislation which also seeks to address concerns with bank sales
of mutual funds and other "nondeposit investment products." It
is my understanding that an attempt to add all of the provisions
of the Gonzalez-Schumer bill to a broader Glass-Steagall reform
proposal failed at the House Banking Committee level, but that
Congressman Flake successfully offered several provisions similar
to those in the Gonzalez-Schumer bill at the Committee level.
Another issue, one that has become even more significant in
the context of Glass-Steagall reform, is whether banks should
conduct their securities activities in subsidiaries or
affiliates. In recent Congressional testimony, a majority of the
Commission supported the concept that bank securities activities
should be limited to nonbank affiliates of the bank holding
company. I joined in this view because I believe that there are
important operational differences between subsidiaries and
affiliates under federal banking law. For example, I understand
that a subsidiary of a bank is considered to be an extension of
the bank itself under federal banking law. Thus, the nonbank
subsidiary's capital is generally included in the calculation of
the parent bank's capital. A nonbank affiliate of a bank holding
company, on the other hand, is separate from the affiliate bank.
The bank holding company must separately capitalize the nonbank
affiliate, and the nonbank affiliate's capital is not counted as
the capital of any affiliate bank. Furthermore, bank
subsidiaries are not subject to the conflict of interest and
self-dealing restrictions that are applicable to bank holding
company affiliates under Sections 23A and 23B of the Federal
Reserve Act.
Bank brokerage and underwriting activities also have raised
concerns and prompted scrutiny. In response to allegations that
banks are "tying" underwriting services and credit products, the
GAO is actively investigating the extent of bank tying practices,
as well as the effectiveness of the anti-tying statute. In fact,
the GAO is scheduled to meet with me on this subject tomorrow,
May 19. Of course, current federal banking law imposes
prohibitions and restrictions on banks against tying arrangements
and other noncompetitive practices in connection with their
securities and mutual fund activities.
The tying complaints of which I have been made aware in the
past usually involved allegations that banks, through over-
aggressive employees, were unfairly competing for municipal
securities underwriting business by tying their credit
enhancements to an underwriting or some other role. For whatever
reason, banking regulators apparently have initiated only two
enforcement actions in this area as of the end of last year, and
I believe that I was the source of both cases.
In my view, taxpayer guaranteed funds should be walled off
from supporting securities activities and mutual fund activities
of banks or their affiliates. Otherwise, banks and their
affiliates may have a substantial advantage in competing for
underwriting and other services, and this is an inappropriate use
of the federal deposit insurance system. If banks are able to
tie extensions of credit to the use of their affiliates'
underwriting or other services, the availability of taxpayer-
backed deposits may give banks a large advantage over independent
underwriters lacking access to federally insured funds. I am
inclined to be of the view that this circumstance is more likely
to occur on the regional or local level than at the national
level, where customers have a wider range of credit alternatives
available.
IV. Glass-Steagall Reform Legislative Initiatives
Debate on broad-based Glass-Steagall reform has eclipsed all
other banking issues in the 104th Congress. Legislative
proposals have been introduced to reform Glass-Steagall in the
House by Chairman Leach and in the Senate by Chairman D'Amato.
Further, the Treasury Department has issued an outline of its own
proposal. All of the proposals would likely facilitate bank
securities activities, which is a concept, by the way, that I do
support.
Although I will try to give a sense of my own views on these
proposals, time restraints may prevent me from going into any
real detail. But let me make a general point up front: the
Commission has not in the past, nor should it in the future,
support any Glass-Steagall reform proposal that does not move
generally towards the concept of "functional regulation." In my
view, only a general system of functional regulation, in which
each entity ordinarily is regulated according to the particular
activity that it undertakes and not according to its charter, can
achieve the twin goals of equal protection for all investors and
reduced regulatory costs. Of course, there are exceptions to any
general rule, and I see no reason, for example, why banks should
not be allowed to underwrite both general obligation and revenue
municipal bonds under the current municipal securities structure.
The experience of bank underwriting of municipal general
obligation bonds has demonstrated no safety or soundness problems
of which I am aware, and I do not understand the distinction
between underwriting municipal general obligation bonds and
municipal revenue bonds.
I understand that the bill reported out of the House Banking
Committee last week generally would allow banks to acquire
securities firms through financial services holding companies and
to conduct significant securities activities in the bank or
through "separately identifiable departments of banks."
Securities firms could acquire uninsured wholesale banks through
an investment bank holding company structure with separately
capitalized broker-dealer affiliates. The reported bill also
contains provisions that would remove the blanket definitional
exclusions for banks under the Exchange Act and the Advisers Act
and would create a financial services policy-making interagency
council comprised of the heads of the banking agencies, the
Treasury, the CFTC and the Commission. The reported bill further
would allow well-capitalized banks to underwrite municipal
general obligation and revenue bonds and would require networking
standards, similar to current banking standards, for bank
brokerage of securities and annuities.
In testimony on an earlier version of the reported bill, the
Commission supported the concept of financial services
modernization generally and praised the earlier version for
moving towards a functional regulation approach. Certainly,
banks and their affiliates should be allowed to engage in other
business activities. Nevertheless, our testimony raised
significant concerns with the earlier version of the bill.
First, a host of provisions would grant banks extensive
exemptions from broker-dealer regulation and thereby depart from
functional regulation principles. Second, the provisions
regarding oversight and examination of bank-affiliated securities
activities would appear to have the effect of increasing the
likelihood of regulatory overlap and conflict. Finally, the
provisions do not appear to provide a real "two-way street" for
securities firms that desired to acquire banks.
The bill reported out of the House Committee included
several amendments to the earlier version which responded to
Commission concerns in the investment company area and with
respect to the "two-way street" issue, but did not respond to the
Commission's other chief concerns. As for functional regulation,
the reported bill was not as strong on this point as it was
initially, and now would permit even more securities activities
to remain within the bank. The bill also appears to overlay bank
safety and soundness regulation on securities firms in a manner
that could impact the vitality of the securities marketplace.
Further, prospects for "regulatory arbitrage" appear to have
increased in the reported bill. In other words, it appears to
provide more options for banks to move securities activities into
and out of different entities based upon the level of regulatory
oversight imposed on each such entity. Finally, the interagency
council is problematic to the Commission because it may undermine
the agency's ability to craft appropriate financial
responsibility standards for broker-dealers. Due to the
disproportionate representation of banking regulators on the
council, it is likely that the council's mandate will be bank
safety and soundness and not investor protection.
In the Senate, Chairman D'Amato's bill is virtually
identical to bills that the Senator introduced in the late 1980s.
A new framework for regulating "financial services holding
companies" would be created, and that framework would permit the
mixing of banking, securities, insurance and commercial
activities. The holding company parent generally would be
unregulated, and certain firewalls and anti-tying restrictions
would limit affiliated transactions between the insured bank and
other holding company affiliates. The various "affiliates" in
this structure would be regulated by their "functional"
regulator. The D'Amato bill also would provide for a joint
committee on financial services, although I believe that it would
have a slightly different make-up than the one called for by the
House Banking Committee.
The Commission has not yet had a formal opportunity to
comment on Chairman D'Amato's bill, either in this Congress or in
its previous incarnations. In general, the bill would appear to
have several positive aspects, particularly with respect to the
"two-way street" and certain functional regulation concerns,
although I do not believe it would provide for functional
regulation for existing bank securities activities where a bank
elects not to be part of a financial services holding company.
To my knowledge, Chairman D'Amato has not scheduled hearings on
his bill, but has stated his willingness to entertain revisions.
Should it become the subject of hearings or further debate, I
hope that the Chairman will consider the Commission's views.
Treasury's proposal on Glass-Steagall reform would permit
affiliations between banks and other firms engaged in "financial
activities," including insurance companies and securities firms,
but would not allow for affiliations between banks and commercial
companies. It too would create an interagency council, but
apparently more to serve as a policy forum rather than as a
regulator. The Treasury proposal would permit banks to establish
or acquire securities subsidiaries; and, as you may recall from
comments that I made earlier, I have significant reservations
about a subsidiary approach. Many of the other aspects of the
Treasury proposal are not yet clearly defined, so I do not
believe that I could comment responsibly thereon.
V. Conclusion
While there appears to be strong support in Congress for
Glass-Steagall reform, it is not clear what form any final
package will take, or even whether a single reform package can be
agreed upon that will be acceptable to the House, the Senate, and
the Administration. As members of this audience probably recall,
Congress has taken steps towards reforming Glass-Steagall at
least two times in recent years, and the previous efforts failed
for reasons that are likely to reappear this year, and they are
issues concerning the insurance industry, firewalls, and
jurisdiction.